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On currency crises and contagion

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This paper analyzes the role of contagion in the currency crises in emerging markets during the 1990s. It employs a non-linear Markov-switching model to conduct a systematic comparison and evaluation of three distinct causes of currency crises: contagion, weak economic fundamentals, and sunspots, i.e. unobservable shifts in agents' beliefs. Testing this model empirically through Markov-switching and panel data models reveals that contagion, i.e. a high degree of real integration and financial interdependence among countries, is a core explanation for recent emerging market crises. The model has a remarkably good predictive power for the 1997-98 Asian crisis. The findings suggest that in particular the degree of financial interdependence and also real integration among emerging markets are crucial not only in explaining past crises but also in predicting the transmission of future financial crises. JEL Classification: F30; E60; E65; E44.

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 139.

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Length: 42 pages
Date of creation: Apr 2002
Date of revision:
Handle: RePEc:ecb:ecbwps:20020139

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Keywords: Currency crises; contagion; Markov-switching; panel data; prediction.;

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